Strategic Financial Management the Main

Strategic Financial Management

The main output of financial accounting process is to provide basic general purpose financial statements. These basic financial statements are Balance Sheet, Income Statement, Statement of Changes in Equity and Retained Earning, and Statement of Cash flows.

These components of the financial statements are interrelated and have to be looked and analyzed as a whole by users. It is a sin to solely look at the bottom line of the income statement and assume that a Company at profit is managing its resources at its full potential. A Company may be stating in its Income Statement profits. However, looking at the Cash Flow Statement, cash flow from operating, financing and investing activity is decreasing or negative. As a result, the net change in Cash is decreasing as well. To further illustrate, let us look at the figures below:

XYZ CORPORATION

STATEMENT of CASH FLOW

FOR the YEAR ENDED DECEMBER 31, 2006

Cash Flow from Operating Activities

Net Income

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation expense

Loss on Sale of Fixed Assets

Increase in account receivable (net)

Increase in inventory

Decrease in accounts payable

Net Cash used by Operating activities

Cash Flow from Investing Activities

Sale of Plant Assets

Purchase of Equipment

Net Cash used by Investing Activities

Cash Flow from Financing Activities

Payment of dividends

Net Cash used by Financing Activities

Net decrease in cash

Cash Balance, January 1, 2006

Cash Balance, December 31, 2006

Cash flow is the summary of cash receipts and cash payments made for the three activities which are operating, investing and financing, during the period.

At first glance, XYZ Company seems to be in good shape considering a $100,000 net income. However, looking closer we can see that cash decreased significantly from $200,000 to $21,000. The decrease is caused by aggressive use of money in the operating, investing and financing activities.

Under the operating activities, the Company may be incurring increase in sales but not generating enough cash because most of the sales are tied up in Accounts Receivables (AR), as evidenced in the increase in AR. Or that the Company may have decided to transact business on cash basis or pay its debt to its suppliers as evidenced on decrease of accounts payable, thus cash outflow incurs. As a result, instead of cash produced, operating activities used $114,000 of its $200,000 fund.

In analyzing the investing and financing activities, the Company decided to outlay $450,000 cash to purchase an equipment and provide cash dividends to shareholders amounting to $250,000, contributing to Cash' further decrease.

With the previous illustration, we can see that the Company may be incurring an income of $100,000 however; it also indicates a decreased of Cash from $200,000 to $21,000. A negative or decrease in Cash Flow may indicate trouble if not properly managed. A decrease in cash by $179,000 may mean its cash is not properly managed enough to fund its business operations. Thus, the Company needs to evaluate and learn to manage its cash to sustain the operations.